Economy & Strategy: The three Rs and the Indian economy :: Ambit

Economy & Strategy: The three Rs and the Indian economy 
Even as slow but sure signs of a turnaround in the Indian economy emerge, the three Rs—the Rupee, Repo rates and the RBI—are likely to determine the strength of the recovery in India in FY14. Factoring in tighter liquidity conditions as well as a stronger-than-expected adverse reaction to the US Fed’s ruminations on tapering QE3, we cut our GDP growth expectations for FY14 from 6.8% YoY to 6.4% YoY. Our base case remains that a global “reallocation trade” in India’s favour is likely to materialise in FY14 given that history suggests that rising bond yields in developed nations (like the US) have historically coincided with strong equity returns in India. 

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Even as slow but sure signs of a turnaround in the Indian economy
emerge, the three Rs—the Rupee, Repo rates and the RBI—are likely
to determine the strength of the recovery in India in FY14. Factoring in
tighter liquidity conditions as well as a stronger-than-expected
adverse reaction to the US Fed’s ruminations on tapering QE3, we cut
our GDP growth expectations for FY14 from 6.8% YoY to 6.4% YoY. Our
base case remains that a global “reallocation trade” in India’s favour
is likely to materialise in FY14 given that history suggests that rising
bond yields in developed nations (like the US) have historically
coincided with strong equity returns in India.
The three Rs and the Indian economy
We have been highlighting that we expect GDP growth in FY14 to record a
positive surprise owing to a combination of higher investment growth, better
monsoons, higher Government expenditure and front-loaded repo rate cuts.
Whilst a host of indicators point to a slow but sure improvement (please refer
to the pages that follow for a range of charts which illustrate this), three
critical macro-economic developments have transpired over the past 30 days,
namely:
 Rupee: During June, a stronger-than-expected adverse reaction to the
Federal Reserve’s ruminations on tapering QE3 translated into a sharp
depreciation of the INR and increased macroeconomic uncertainty.
 Repo rates: On 17 June, the RBI indicated that it is unlikely to cut rates
despite slowing growth owing to currency concerns (we had expected
further rate cuts of 50-75bps in FY14).
 RBI: On 15 July, the RBI decided to sacrifice liquidity for the sake of
exchange rate stability whereby it increased the Marginal Standing Facility
(MSF) rate by 200bps.
In view of these developments, we pare our GDP growth estimate from 6.8%
in FY14 to 6.4% whilst maintaining our view of a positive GDP growth surprise
in FY14 (see Exhibit B on the right-hand margin and refer to Appendices I and
II on pages 9-11 for details of the model).
Can India be the first in line for the reallocation trade?
Our strategist, Gaurav Mehta, points out that phases characterised by rising
bond yields in developed nations (like the US) have historically coincided with
strong equity returns in India. Rising bond yields in the US are typically a
precursor to a reallocation trade into emerging market equities.
Also, and this of critical import, India is the only country among the BRICs
where the slide in GDP growth has halted. Furthermore, India is a commodity
‘importer’ (hence, it benefits from lower commodity prices). Thus, India should
logically be the first in line for the looming ‘reallocation trade’.
Investment implications
Given that we expect GDP growth in FY14 to surprise on the upside, we once
again point clients to our model portfolio, - G&C 6.0 (published on 13th June)
- as to benefit from the coming economic recovery (refer to Exhibit C on the
right-hand margin for our top picks from this portfolio). At the market level,
we reiterate our long-standing year ending target of 23K on the Sensex,
implying 15% upside (most of which should come from EPS growth in FY14).Even as slow but sure signs of a turnaround in the Indian economy
emerge, the three Rs—the Rupee, Repo rates and the RBI—are likely
to determine the strength of the recovery in India in FY14. Factoring in
tighter liquidity conditions as well as a stronger-than-expected
adverse reaction to the US Fed’s ruminations on tapering QE3, we cut
our GDP growth expectations for FY14 from 6.8% YoY to 6.4% YoY. Our
base case remains that a global “reallocation trade” in India’s favour
is likely to materialise in FY14 given that history suggests that rising
bond yields in developed nations (like the US) have historically
coincided with strong equity returns in India.
The three Rs and the Indian economy
We have been highlighting that we expect GDP growth in FY14 to record a
positive surprise owing to a combination of higher investment growth, better
monsoons, higher Government expenditure and front-loaded repo rate cuts.
Whilst a host of indicators point to a slow but sure improvement (please refer
to the pages that follow for a range of charts which illustrate this), three
critical macro-economic developments have transpired over the past 30 days,
namely:
 Rupee: During June, a stronger-than-expected adverse reaction to the
Federal Reserve’s ruminations on tapering QE3 translated into a sharp
depreciation of the INR and increased macroeconomic uncertainty.
 Repo rates: On 17 June, the RBI indicated that it is unlikely to cut rates
despite slowing growth owing to currency concerns (we had expected
further rate cuts of 50-75bps in FY14).
 RBI: On 15 July, the RBI decided to sacrifice liquidity for the sake of
exchange rate stability whereby it increased the Marginal Standing Facility
(MSF) rate by 200bps.
In view of these developments, we pare our GDP growth estimate from 6.8%
in FY14 to 6.4% whilst maintaining our view of a positive GDP growth surprise
in FY14 (see Exhibit B on the right-hand margin and refer to Appendices I and
II on pages 9-11 for details of the model).
Can India be the first in line for the reallocation trade?
Our strategist, Gaurav Mehta, points out that phases characterised by rising
bond yields in developed nations (like the US) have historically coincided with
strong equity returns in India. Rising bond yields in the US are typically a
precursor to a reallocation trade into emerging market equities.
Also, and this of critical import, India is the only country among the BRICs
where the slide in GDP growth has halted. Furthermore, India is a commodity
‘importer’ (hence, it benefits from lower commodity prices). Thus, India should
logically be the first in line for the looming ‘reallocation trade’.
Investment implications
Given that we expect GDP growth in FY14 to surprise on the upside, we once
again point clients to our model portfolio, - G&C 6.0 (published on 13th June)
- as to benefit from the coming economic recovery (refer to Exhibit C on the
right-hand margin for our top picks from this portfolio). At the market level,
we reiterate our long-standing year ending target of 23K on the Sensex,
implying 15% upside (most of which should come from EPS growth in FY14).